BSBFIM801 Manage Financial Resources-1
Assignment No. 1-Short answer questions
Explain the 5 x ‘A’s of Financial Management scope
Financial management has a wide scope. According to Dr. S. C. Saxena, the scope of financial management includes the following five ‘A’s.
1.Anticipation : Financial management estimates the financial needs of the company. That is, it finds out how much finance is required by the company.
2.Acquisition : It collects finance for the company from different sources.
3.Allocation : It uses this collected finance to purchase fixed and current assets for the company.
4.Appropriation : It divides the company’s profits among the shareholders, debenture holders, etc. It keeps a part of the profits as reserves.
5.Assessment : It also controls all the financial activities of the company. Financial management is the most important functional area of management. All other functional areas such as production management, marketing management, personnel management, etc. depends on Financial management.
Efficient financial management is required for survival, growth and success of the company or firm.
Explain ‘Working Capital”.
Working Capital is the difference between current assets and current liabilities. A business without sufficient working capital cannot pay its debts as they fall due. In this situation it may have to stop trading even if it is profitable.
Explain ‘Cash Management’.
Cash management is the corporate process of collecting and managing cash, as well as using it for short-term investing. It is a key component for a company's financial stability and solvency.
Explain ‘Cash Flow’
The statement of cash flows is a summary of money coming into and going out of the organisation over a specific period of time. It is prepared at regular intervals (usually monthly and at financial year end) to show the sources (where the cash comes from) and uses (where cash was spent) of cash for a given period.
For NFPOs, this statement will clearly set out the cash impact of any trading activities as a comparison against cash received from contributions.
The cash flows (in and out) are summarized on the statement in three categories as follows:
Operating activities: These are the day-to-day activities that arise from the selling of goods and services and usually include:
• Receipts from trading income
• Payments for expenses and employees
• Funding of debtors
• Funding from suppliers (i.e. the supplier supplies goods on credit)
• Stock movements
Investing activities: These are the investments in items that will ensure or promote the future activities of the organization. They are the purchase and sale of fixed assets, investments or other assets and can include such items as:
• Payment for purchase of plant, equipment and property
• Proceeds from the sale of plant, equipment and property
• Payment for new investments, such as shares or term deposits
• Proceeds from the sale of investments
Financing activities: These are the activities by which an organization finances its operations via the proceeds of borrowings and equity injections, the repayment of debt or equity and the payment of dividends (Renz, 2016). Examples of the types of cash flow included in financing activities include:
• Proceeds from additional injection of funds into the organization. For NFPOs this will include contributions
• Cash borrowed
• Repayment of cash borrowed
Explain ‘Inventory Management’.
Inventory management refers to the process of ordering, storing and using a company's inventory: raw materials, components and finished products.
Explain what is an ‘Income Statement’?
This is a financial statement that measures a business’s financial performance over a specific accounting period by giving a summary of how it incurs its revenues and expenses. It also shows the net profit or loss incurred over that period and is often referred to as a ‘Profit and Loss’ or ‘Revenue and Expenses’ statement. An income statement consists of two sections: operating and non-operating activities.
- The operating section details the revenue and expenses directly associated with business operations, for example the purchase of raw materials.
- The non-operating section details revenue and expenses that result from activities outside of normal business operations, for example the sale of an office or land.
Figure 1: Income Statement terms
(Source: Renz, 2016)
The income statement uses three terms that can be defined as:
• Revenue—incoming assets in return for sold goods or services.
• Expenses—outgoing assets or liabilities incurred.
• Net Income—the difference between Revenue and Expenses. This shows whether you are generating a profit or you are operating at a loss.
Explain what is a ‘Balance Sheet’?
Balance Sheet is the financial statement of a company which includes assets, liabilities, equity capital, total debt, etc. at a point in time. Balance sheet includes assets on one side, and liabilities on the other. For the balance sheet to reflect the true picture, both heads (liabilities & assets) should tally (Assets = Liabilities + Equity).
Explain the ‘Accounting Equation”.
The accounting equation, also known as the balance sheet equation, is written as Assets = Liabilities + Equity and underpins the balance sheet's foundation. The accounting equation is the foundation of double entry accounting, and displays that all assets are either financed by borrowing money or paying with the money of the company's shareholders (Sharma et al.2016).
Explain ‘Cash Accounting’.
This is an accounting method where receipts are recorded on the date they are received and the expenses on the date that they are actually paid. As a small business, Susy has the option of ‘cash accounting,’ which means that she only needs to record transactions at the point of payment. In other words when the money leaves or is paid into her bank account.
Explain ‘Accrual Accounting’.
Accrual accounting is considered to be the standard accounting practice for most businesses, and is mandated for businesses of any real size.
Figure 2: Accrual Accounting
(Source: Sharma et al.2016)
The accrual method recognizes a sale at the point at which the customer takes ownership of the goods or the point when the service is delivered, even though the cash isn’t yet in the bank. Similarly, costs may be recognized before an invoice is received if the business accepts that the cost has been incurred during the accounting period. This method provides a more accurate picture of the business’s current condition, but it is more complex to administer when payments received are less than the amount invoiced. This can happen if the customer disputes the amount or simply refuses to pay.
Explain ‘Profit Margin’.
A business’s profit margin can be expressed as a ratio or by product as a percentage. The ratio is calculated as net profits (or net income) divided by revenue (sales). It measures how much out of every dollar of sales a business actually keeps in earnings. This is often expressed as a percentage where the difference between the selling price and the cost price is divided by the selling price. This answer is then multiplied by 100 to become a percentage. For example,
Figure 3: ‘Example’ for Profit Margin
(Source: Sharma et al.2016)
Explain ‘Financial Risk’.
Financial risk is the possibility that shareholders or other financial stakeholders will lose money when they invest in a company that has debt if the company's cash flow proves inadequate to meet its financial obligations.
There are many types of financial risks. The most common ones include credit risk, liquidity risk, asset backed risk, foreign investment risk, equity risk and currency risk.
Credit risk is also referred to as default risk. This type of risk is associated with people who borrowed money and who are unable to pay for the money they borrowed. As such, these people go into default. Investors affected by credit risk suffer from decreased income and lost principal and interest, or they deal with a rise in costs for collection.
b. Liquidity risk involves securities and assets that cannot be purchased or sold fast enough to cut losses in a volatile market.
c. Asset-backed risk is the risk that asset-backed securities may become volatile if the underlying securities also change in value. The risks under asset-backed risk include prepayment risk and interest rate risk.
What is a ‘Financial Decision’?
Decisions concerning the liabilities and stockholders' equity side of the firm's balance sheet, such as a decision to issue bonds.
The three main decisions taken by the committee that principally caused the financial collapse were:
1. The employment of a Coaching Director (full-time salary plus car remuneration package)
2. The commencement of a building project to improve the clubhouse. The building works were substantially funded by government, but the club still had to put in its agreed share.
3. The ambition of the club to be promoted to the highest league. This ambition involved paying wages to players and coaching staff.
Explain a ‘Liquidity Decision’.
Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real estate market, allows assets to be bought and sold at stable prices. Cash is considered the most liquid asset, while real estate, fine art and collectibles are all relatively illiquid.
Accounting liquidity measures the ease with which an individual or company can meet their financial obligations with the liquid assets available to them.
Explain the difference between ‘Financial Forecasting’ and ‘Financial Reporting’.
Financial Forecasting: When a company conducts its financial forecasts, it seeks to provide the means for the expression of its goals and priorities to ensure they are internally consistent. It can also help a company identify the assets or debt needed to achieve its goals and priorities.
A good example of a financial forecast is the forecasting of a company's sales. Since most financial statement accounts are related to or tied to sales, forecasting sales can help a company make other financial decisions that support achieving its goals.
Financial Reporting: Financial modeling, on the other hand, is the process by which a company builds its financial representation. The model created as a result of financial modeling is used to make business decisions (Romo, 2015). Financial models are the mathematical models made by a company in which variables are linked together the company can modify these variables to see how the changes could affect the business.
Financial models are used for historical analysis of a company, projecting the full performance of a company, equity or investment research or project finance analysis. They are used to create pro forma financial statements.
Financial modeling takes the financial forecasts created during a company's financial forecasting and builds a predictive model that helps a company make sound business decisions based on its forecasts and assumptions.
Explain ‘Capital Structure’.
The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure.
Explain ‘Cost of Capital’.
Cost of capital is the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity. Another way to describe cost of capital is the cost of funds used for financing a business. Cost of capital depends on the mode of financing used — it refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt (Finke, Howe & Huston, 2016). Many companies use a combination of debt and equity to finance their businesses and, for such companies, the overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC). Since the cost of capital represents a hurdle rate that a company must overcome before it can generate value, it is extensively used in the capital budgeting process to determine whether the company should proceed with a project.
How often are actual income and expenditure figures checked against the budget? Who is responsible for this and who is this information passed on to within an organisation?
The actual income and expenditure figure are being checked at the end of September every year and determines expenditure to date against budget. The information is passed between the managers and the employees of an organization.
What is meant by the term “management by exception”? Explain in detail.
Management by exception is the practice of examining the financial and operational results of a business, and only bringing issues to the attention of management if results represent substantial differences from the budgeted or expected amount. For example, the company controller may be required to notify management of those expenses that are the greater of $10,000 or 20% higher than expected.
The purpose of the management by exception concept is to only bother management with the most important variances from the planned direction or results of the business. Managers will presumably spend more time attending to and correcting these larger variances. The concept can be fine-tuned, so that smaller variances are brought to the attention of lower-level managers, while a massive variance is reported straight to senior management.
Advantage of management by Exception
- It reduces the amount of financial and operational results that management must review, which is a more efficient use of their time.
- The report writer linked to the accounting system can be set to automatically print reports at stated intervals that contain the predetermined exception levels, which is a minimally-invasive reporting approach.
Disadvantage of management by Exception
- This concept is based on the existence of a budget against which actual results are compared. If the budget was not well formulated, there may be a large number of variances, many of which are irrelevant, and which will waste the time of anyone investigating them.
- The concept requires the use of financial analysts who prepare variance summaries and present this information to management. Thus, an extra layer of corporate overhead is required to make the concept function properly. Also, an incompetent analyst might not recognize a potentially serious issue, and will not bring it to the attention of management.
In static budget the sales forecast is $405,000 and but the true amount at the end of the financial period is $620,000. What is the sales budget variance in both $ and % amounts?
Formula: Static budget/True budget*100
Formula: True budget-Static budget
Which of the following is likely to lead to a favorable budget variance?
a. Increased competition: With the increase in competition companies will have to take necessary budgeting decisions so as to prepare its budgeting process. It can be said as increase in competition will lead to a favorable budget variance
b. A major competitor going bust: In this context it will be easy for a company to take up its own budgeting procedures and ultimately the demand within the customer will increase as there is no other company to compare to.
An increase in the cost of raw materials
Raw material price fluctuations influence the price of the goods. The supply of a product would decrease with increase in the cost of production and vice versa. The supply of a product and cost of production are inversely related to each other.